Carrier Revisited

President-elect Donald Trump has claimed victory in his effort to preserve employment for Carrier workers in Indiana.  Assisted by $7 million in tax incentives provided by the State of Indiana, Mr. Trump persuaded the company not to move 800 furnace manufacturing jobs to Monterrey, Mexico.  This works out to a taxpayer-funded subsidy of $8750 per job. 

Another 1300 Carrier jobs still will move to Mexico between now and 2019.  Published reports have indicated that the company anticipated cost savings of some $65 million per year from moving all 2100 positions to Monterrey.  So Carrier is taking at least a partial step toward maintaining its global competiveness, while at least partially appeasing the incoming president.

I wrote an op-ed in Forbes on August 22, 2016, in which I argued that Carrier no doubt had quite good business reasons for planning the move to Mexico.  Carrier’s February 2016 announcement of the decision said that it was due to “ongoing cost and pricing pressures driven, in part, by new regulatory requirements.”  

Carrier has been manufacturing products in Monterrey for some years.  The company certainly has a clear understanding of why moving production of some air conditioning units makes business sense.  It would not be wise for them to explain their reasoning in public because such proprietary knowledge would be of great interest to their competitors. 

Some commentators have opined that the decision was driven largely by lower labor costs.  Carrier’s expenses for employee salary and benefits average about $34 per hour in Indiana, while those costs in Mexico are only around $6 per hour.  It’s possible the move was prompted primarily by labor cost savings, although my analysis of data compiled by The Conference Board suggests otherwise.  The value generated by an hour worked in the United States has risen by 40 percent over the past 22 years of NAFTA.  In Mexico, the gain has been only 10.5 percent.  Productivity has grown faster in the United States, so the incentive to shift production to Mexico today ought to be weaker than it was 10 or 20 years ago.  (Note:  Those figures apply to the productivity of all workers.  If it was possible to analyze just the manufacturing sector, perhaps the findings would change.)

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Pentagon Bureaucracy: $125 Billion in Waste

The Washington Post has a blockbuster story today documenting vast overhead costs in the Department of Defense (DoD). Experts often lambast the DoD’s excessive bureaucracy, and I have charted the growth in the number of civilian DoD workers.

But the Post reveals remarkable new measures of the department’s bloat, based on a leaked study it obtained:

The Pentagon has buried an internal study that exposed $125 billion in administrative waste in its business operations amid fears Congress would use the findings as an excuse to slash the defense budget, according to interviews and confidential memos obtained by The Washington Post.

Pentagon leaders had requested the study to help make their enormous back-office bureaucracy more efficient and reinvest any savings in combat power. But after the project documented far more wasteful spending than expected, senior defense officials moved swiftly to kill it by discrediting and suppressing the results.

The study was produced last year by the Defense Business Board, a federal advisory panel of corporate executives, and consultants from McKinsey and Company. Based on reams of personnel and cost data, their report revealed for the first time that the Pentagon was spending almost a quarter of its $580 billion budget on overhead and core business operations such as accounting, human resources, logistics and property management.

The data showed that the Defense Department was paying a staggering number of people — 1,014,000 contractors, civilians and uniformed personnel — to fill back-office jobs far from the front lines. That workforce supports 1.3 million troops on active duty, the fewest since 1940.

The DoD’s effort to bury the study is appalling, but Pentagon waste is a complex problem. You can’t just chop $125 billion worth of “back office” jobs overnight. However, it is also true that the 1,014,000 such jobs—in logistics, procurement, and other activities—are the exact types of functions that have become vastly more efficient in the private sector.

Pentagon Spikes Report on Waste Because It Found Too Much

In 2014, the Pentagon commissioned a study to identify wasteful practices and improve efficiency, but when the researchers found too much waste – approximately $125 billion worth – the officials who asked for the report tried to bury the findings. As reported in the Washinton Post, Pentagon officials worried that “Congress would use the findings as an excuse to slash the defense budget.”

The Pentagon imposed secrecy restrictions on the data making up the study, which ensured no one could replicate the findings. A 77-page summary report that had been made public was removed from a Pentagon website.

Particularly telling are a series of comments by Deputy Defense Secretary Robert O. Work, the Pentagon’s second-highest-ranking official, and Frank Kendall III, the Pentagon’s chief weapons-buyer. 

Heritage Foundation Infrastructure Proposals

In a new report for the Heritage Foundation, Michael Sargent summarizes what we need on infrastructure from the incoming Trump administration. I agree with all of Michael’s points, which I paraphrase here:

  • Ignore rhetoric about crumbling highways and falling-down bridges. America’s infrastructure needs improvements, but the scare stories are off-base.
  • Reduce government red tape to speed investment.
  • Repeal harmful labor rules, which raise the costs of infrastructure construction.
  • Embrace privatization.
  • Approve energy projects blocked by the Obama administration.
  • Repeal the net neutrality regulations on the Internet.
  • Limit regulations on emerging technologies.
  • Cut the federal highway gas tax, end spending on urban transit, and reduce the federal role in highways.
  • Privatize air traffic control, eliminate subsidies for airports, and remove barriers for the states to restructure airports as self-funded businesses.
  • Do not pass a federal infrastructure spending stimulus.
  • Do not use repatriated corporate earnings for a government stimulus. If such revenues arise from corporate tax reform, use them to reduce the corporate tax rate.
  • Do not create new tax loopholes or subsidies for infrastructure.
  • Do not create a federal infrastructure bank. That would lead to more bureaucracy, subsidies, and central control.

I would add to Michael’s points that I share concerns expressed by Trump and others that America should have world-class infrastructure. But the way to get it is not through subsidies, regulations, and centralization. Instead, the incoming administration should focus on market-based reforms to privatize facilities, reduce subsidies and regulations, and increase competition.

For more information on infrastructure reforms, see here, here, here, and here.

TPC “Experts” Don’t Know Who Gets What Share of Trump Tax Cuts

According to Wall Street Journal writer Laura Saunders, future Treasury Secretary Mnuchin must be wrong because Tax Policy Center experts say so. Actually, Mr. Mnuchin may be partly right, but the experts are almost entirely wrong.

“Steven Mnuchin, the likely next Treasury secretary, this week said rich U.S. taxpayers won’t get “an absolute tax cut” under President-elect Donald Trump,” writes Ms. Saunders; “But that is not what Mr. Trump says in his taxation plan. In fact, under his approach the wealthy would receive an average tax cut of about $215,000 per household, experts say.” 

“What Mr. Trump says” is not at all the same as what some “experts say.” Expert or not, Tax Policy Center (TPC) estimates of who pays what under different tax rates are distressingly capricious.

Mr. Mnuchin appeared to be talking only about individual income taxes. That is why he suggested that lower marginal tax rates for high earners “will be offset by less deductions.” So long as we focus only on non-business taxes (including high salaries and dividends), Mr. Mnuchin was probably right. Indeed, according to Ms. Saunders’ experts, the lost revenue from lower tax rates over 10 years totals $1.49 trillion plus $145 billion from eliminating the 3.8% Obamacare surtax.  Yet those individual tax cuts are more than offset by $2.6 trillion in added revenue from Trump’s cap on itemized deductions and the loss of personal exemptions. More than doubling the standard deduction loses considerable revenue, but not from high-income taxpayers.

Ms. Saunders mentions only the loss of itemized deductions—not exemptions—and concludes “these limits don’t fully offset the effects of income- and estate-tax cuts for high earners proposed by Mr. Trump, according to experts.” 

Repealing the estate tax loses very little revenue, but it is arbitrary for the TPC to assign that lost revenue to people with high incomes because the estate tax is borne by heirs and charities—not dead people.

With estate tax repeal included, only 22% of the Trump tax cut goes to households (including investors) according to the TPC, with 44% of Trump tax cuts going to corporate earnings (and the rest to unincorporated business). 

Problems with Paid Family Leave Redux

Last week I wrote about the unintended consequences of the proposed DC family leave benefit, which is to be financed by a payroll tax on all employers in the District. 

My objections were that the tax increases the cost of operating in the District and that this will likely push some businesses contemplating opening in DC to Maryland or Virginia instead. The other objection I had was that it specified a benefit to be provided that not all companies may want to provide. In an ideal world companies would pay wages to workers and then allow workers to get their own insurance, pensions, transportation, food, and the like on their own and not have these things provided by their workplace. Today, the tax breaks afforded most fringe benefits behoove companies to give many of these things to their workers in lieu of wages, and that’s not efficient. 

I received a surprising amount of feedback from my article, most of which was positive—a first for me—and some readers suggested that I missed a couple issues relevant to the benefit. The first is that while tying the tax to payroll may make sense as far as this benefit is concerned, it also tends to make it more difficult for people to understand the true cost involved. 

A tax that’s .62% of payroll may not seem like a lot, but for a restaurant that has $1 million of revenue that translates to a tax of $2,100 a year, assuming that payroll is one-third of total revenue. For businesses other than restaurants, where payroll typically equals two-thirds of revenue, double that number. That amounts to 2.2% instead of 4.4% of profits, on top of the 8.95% DC corporate profits tax on revenue over $1 million. If they expand the tax to cover medical leave as well—which is on the table—that would add another thousand dollars or so to a restaurant’s cost of doing business. In fact, a better way to see this is as a 50% increase on the tax on business profits, except that this doesn’t vary much with the business cycle.

The other point a restaurant owner suggested to me is that their workers are typically young and part-time, and often have another job. In short, they see this as a benefit few of their twenty-something employees would claim, yet they still would be paying for it. Fortune 500 companies may find the tax easy to swallow, but not so for businesses like my local kebab house that are on the verge of hanging on. This tax, combined with a sharply higher minimum wage and other government mandates—such as the city’s inexplicable refusal to charge for-profit food trucks to use city-owned property for their business, increasing restaurants’ competition further—are hurting their bottom lines, and life is getting more precarious for businesses on the margins. 

What Does Trump Think of Foreign Investment in the United States?

Over the course of the presidential campaign, and even more intensely after the election, Donald Trump has made it very clear that he does not like it when U.S. companies invest abroad rather than here at home (except for his companies, of course). His response has been a mixture of pushing state government tax incentives to keep them at home and general haranguing of the companies (as he did with Carrier), as well as threats of tariffs to convince companies not to leave (this sounds like one of those statements that should be taken “seriously but not literally,” but we’ll see).

With regard to the general policy issues here, my colleague Dan Ikenson has been taking on misguided concerns about outsourcing for a while now.

In terms of the legality of a company-specific tariff, we would need to see a specific proposal—is this going to be done via statute? by Presidential proclamation?—but there would certainly be some serious domestic and international legal hurdles if Trump actually tries to pursue this. I’m not sure what Trump’s economic policies will do for the economy as a whole, but the field of international trade law will be booming.

But there’s also a flip side to the issue of foreign investment that I want to raise here: What does Trump think about foreign companies who want to invest in the United States? This question may seem like a no-brainer: Who would object to new investment? But in recent years, the Obama administration has looked skeptically at some of the investment coming from China, on purported national security grounds. Here’s the latest, from the Wall Street Journal:

President Barack Obama on Friday took the rare step of forbidding a foreign company from buying a firm with U.S. assets, telling a Chinese investment fund that it cannot complete a deal for German technology company Aixtron SE.

Mr. Obama’s move, only his second outright ban on a foreign acquisition, shows the increasing suspicion the U.S. harbors toward Chinese acquisitions of certain U.S. firms, even before the arrival of President-elect Donald Trump, who made criticism of Beijing a cornerstone of his campaign.

In a statement released on Friday, the Treasury Department said Mr. Obama had issued an order barring Fujian Grand Chip Investment Fund LP, part-owned by the Chinese government, from buying Aixtron. The ban follows a recommendation from the Committee on Foreign Investment in the U.S., or CFIUS, which confidentially reviews foreign acquisitions solely on national-security grounds.

U.S. officials have also intervened in Chinese deals involving real estate near strategic military installations. In 2012, Mr. Obama barred Chinese-owned Ralls Corp. from purchasing wind farms in Oregon near a sensitive military facility, the only other recent example of a president forbidding a deal before Friday.

What are Trump’s views on Chinese foreign investment in the U.S.? The WSJ article notes:  

During the 2016 primary season Mr. Trump appeared to criticize a Chinese bid for a small U.S. stock exchange, but his transition team hasn’t publicly spelled out its attitude toward foreign investment.

Still, Mr. Trump, who has extensive foreign investments himself, has indicated he would use all available levers against harmful trade practices from China and other countries. CFIUS under Mr. Trump could also expand the definition of national security to include food security and oppose deals from countries that don’t allow comparable U.S. investments, according to a memo obtained by CNN.

In the background of this issue is a bilateral investment treaty that has been under negotiation between the United States and China for many years, and that until recently some people were suggesting could be completed this year. The basic idea is that, through this treaty, China would promise to open up its market to foreign investment in currently closed sectors, and also that there would be an international dispute mechanism under which foreign investors could sue the host country government if certain rights were violated.

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